“Pre-IPO” investing involves buying securities in a company before the company makes its initial public offering (“IPO”). In a pre-IPO transaction, investors are often enticed to invest in start-up enterprises at the early stages of the company by promising high returns in the future when the company ultimately conducts its IPO. The U.S. Securities and Exchange Commission (the “SEC”) has emphasized that “. . . investing at the pre-IPO stage can involve significant risk for investors.”

Executive Summary

The SEC brought its first cases in the pre-IPO securities space nearly four years ago in March 2012 and has continued investigative actions in this area. Moreover, the SEC has issued two Investor Alerts regarding the risks associated with pre-IPO securities. The SEC continues to probe pre-IPO transactions with a concern over the lack of transparency in the private offering of derivative instruments, such offerings being governed by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), which grants the SEC regulatory authority over all security-based swap transactions, and Section 5(e) of the Securities Act of 1933 and Section 6(l) of the Securities Exchange Act of 1934, which govern the sale of security-based swaps. Together these provisions prohibit security-based swap transactions involving persons who are not “eligible contract participants”, unless an effective registration statement has been filed and the transaction is effected on and through a national securities exchange. SEC actions are ongoing and the effects are still yet to be determined.

First SEC Enforcement Actions in the Pre-IPO space

Each of the three initial 2012 SEC actions surrounding pre-IPO securities, as described in more detail below, alleged different violations but the SEC filed them all at once, helping to illustrate the common pitfalls accompanying this new marketplace as the trading of pre-IPO shares on the secondary market was evolving. Key points included:

  • SEC v. Frank Mazzola, Felix Investments LLC, and Facie Libre Management Associates LLC: The SEC’s complaint alleged that a series of fraudulent misrepresentations and deceptions were made to lure investors, including a statement that Felix Investments and the investment manager were “Facebook approved” when, in fact, Facebook was refusing shares to Felix Investments using the right of first refusal. A final judgement was entered in March 2014 whereby, amongst other sanctions and conditions, Mazzola was barred from association with any investment adviser or related service for three years (at which point he could reapply for re-entry).
  • In the Matter of SharesPost Inc. and Greg Brogger: The SEC alleged that SharesPost was operating as a broker-dealer because it was receiving compensation for matching buyers and sellers of pre-IPO securities via an online service. SharesPost subsequently registered as a broker-dealer but this was an important action as it illustrated the broad reach of the broker-dealer registration requirements.
  • In the Matter of EB Financial Group LLC and Laurence Albukerk: Albukerk was a registered broker-dealer and the SEC allegations surrounded undisclosed related party transactions. The action ultimately settled but highlighted that the SEC is always concerned that investors obtain full and complete information.

Continued SEC Enforcement Actions

In December 2014, the SEC charged a stock promoter with fraudulently raising approximately $3.5 million from investors claiming to purchase Facebook and Twitter shares prior to their IPOs. The SEC alleged that instead of purchasing securities in the secondary market as promised, Efstratios Argyopoulos and his firm Prima Capital Group misappropriated investor funds and “capitalized on the high demand for pre-IPO Facebook and Twitter shares to steal investor money and secretly fund his own day trading.” Argyopoulos and the SEC reached a settlement. The SEC separately announced an administrative proceeding against Khaled A. Eldaher alleging that he reached a side agreement with Argyopoulos to solicit investors and receive 50 percent of the mark-up on Facebook shares he sold.

SEC Investor Alert: Risky Business: “Pre-IPO” Investing

In the wake of the December 2014 actions, the SEC issued an Investor Alert in January 2015 entitled “Risky Business: “Pre-IPO” Investing” where the SEC made a broad statement that “pre-IPO offerings targeted at the general public – especially those that are publicized through “spam” emails – are often fraudulent and illegal.” Moreover, the SEC highlighted that “to lure you in, [the companies] make unfounded comparisons between their company and other established, successful Internet companies. But these and other claims that sound so believable at first often turn out to be false and misleading.” This Investor Alert illuminated that as of January 2015 the SEC had seen a significant amount of abuse in the marketplace and signalled that more enforcement may be likely turning to this area.

Sand Hill

In June 2015, the SEC filed its first enforcement action under the Dodd-Frank Act’s new provisions regulating security-based swap contracts. In this action, Matter of Sand Hill Exchange, Gerrit Hall, and Elaine Ou (“Sand Hill”), the SEC highlighted that “the Dodd-Frank Act prohibits security-based swaps from being offered in the darkness to retail investors, and we were able to act quickly before any losses materialized in this offering that occurred outside the proper regulatory framework.” The Dodd-Frank Act implemented two key requirements for any security-based swaps offering to retail investors that are not “eligible contract participants” as defined in the law: a registration statement must be effective for the offering, and the contracts must be sold on a national securities exchange.

In Sand Hill, the company was a small Silicon-valley start-up that had been running for 7 weeks with 83 individuals, mostly friends and co-workers, trading 2,300 contracts with an approximate aggregate value of $10,000, providing approximately $5,000 in profit to the company. This highlighted that although the Dodd-Frank Act might be seen to govern complicated swaps, it had a far-reach and this small start-up was used to enforce a bigger principle that involving retail investors in even small transactions runs afoul of U.S. securities laws.

As an aside, antagonising regulators is never a good idea - even where you are using public information and legal means! Sand Hill knew it was being investigated and posted a series of blog entries detailing the repeated use of its site by the SEC. The SEC considered this to be a serious affront and viewed this as publishing personal information about the SEC investigators. This was not a good strategic move by Sand Hill, especially given the SEC’s emphasis on full cooperation with any investigation.

SEC Investor Alert: Beware of Fantasy Stock Trading Websites Offering Real Returns

On the same day as Sand Hill, the SEC issued another Investor Alert in June 2015 entitled “Beware of Fantasy Stock Trading Websites Offering Real Returns.” The SEC warned investors that “even when the site presents the transaction as a “fantasy” trading game or competition, and even when it involves only small amounts of money (sometimes called an “entry fee”), you should understand these sites may be violating laws designed to protect investors.”

Recent SEC Probe of Pre-IPO Securities Sales

A new SEC investigation is examining the sale of private technology stocks to determine if certain hedge funds and other investors are improperly trading those shares.

In a recent interview, former SEC Chairman Arthur Levitt commented on the probe saying “what I think [the SEC] is looking at is to see to it that any derivatives transactions are done on an exchange and not over the counter as before Dodd-Frank.” Levitt went on to state that “I don’t think it generally is a healthy thing to be selling unlisted securities privately [over the counter] . . . as a general notion I would like to see the money going to the company rather than to see valuations that are imprecise, at best, for employees to sell their stock on the second market.”

On 25 November 2015, the SEC ordered an unregistered brokerage firm, NetCirq, to comply with an SEC subpoena sent on 7 April 2015. The SEC’s application explains that “NetCirq claims that is has conducted a number of transactions of securities involving pre-IPO companies, however, none of the transactions have been conducted pursuant to a registration statement, nor were they executed on a national securities exchange.” Furthermore, NetCirq is not a registered broker-dealer. The filing, in a San Francisco federal court, says the SEC broadly is investigating whether trading of pre-IPO shares could violate securities laws under the Dodd-Frank Act because some of the transactions could be considered “swaps,” or agreements whose value is tied to a future event.


As illuminated above, the SEC has turned its attention to the regulation of the secondary market for shares of private companies. One major area of concern for the SEC is where investment advisors misrepresent that they are buying pre-IPO shares in “hot” companies but don’t actually purchase them. Given the continued desirability by investors for pre-IPO shares, we expect to see more SEC enforcement action in this area with a focus on transparency and ensuring that all transactions are conducted in regulatory compliance.

For more information:

See the SEC Release (November 2015) entitled “SEC Files Subpoena Enforcement Action Against Netcirq, LLC for Failure to Produce Documents” here. [https://www.sec.gov/litigation/litreleases/2015/lr23418.htm]

See the SEC Investor Alert (June 2015) entitled “Beware of Fantasy Stock Trading Websites Offering Real Returns” here. [http://www.sec.gov/oiea/investor-alerts-bulletins/ia_fantasytrading.html]

See the SEC Investor Alert (January 2015) entitled “Risky Business: “Pre-IPO” Investing” here. [http://www.sec.gov/investor/pubs/preipo.htm]